Financial Reporting

Everyone says financial reports are important for your business.

But, why? Why are they important?

In this series, I’ll help you understand the four reports to check in your business:

  • the balance sheet (this post)
  • the income statement
  • the cash flow statement
  • the chart of accounts

But most important, I’ll help you understand why. Let’s get to it!

All about Balance

In business, real success comes from balance.

If you spend more than you sell, you’re out of balance. If you owe more than you can afford, you’re out of balance.

In accounting, you’ve heard of debits & credits.

Well, debits = credits.

Balance.

Debits are any amounts on the left side. Credits are any amounts on the right side.

They can be any accounts or categories, but to balance, you need the left side amounts to equal the right side amounts.

When you look at your balance sheet, you’ll see what’s called the accounting equation:

Assets = Liabilities + Equity

A balance sheet is a picture of your business (all its assets, liabilities and equity) on a particular day or point in time.

In an ideal business situation, you’ll have more assets than liabilities.

For example, let’s say this is your balance sheet as of last month:

Your Business

Balance Sheet

LastMonth 31, 2018

 

Assets

Checking Account $1000

Accounts Receivable $500

Total Assets $1500

 

Liabilities

Wages Payable $350

Accounts Payable $150

Total Liabilities $500

 

Equity

Owner’s Equity $1000

Total Liab. & Equity $1500

 

Assets = Liabilities + Equity

$1500 = $500 + 1000

Balance.

Let’s have a look at what all these terms mean, so your balance sheet has more meaning.

Balance Sheet Accounting

Assets (What Do You Own in Your Business)?

On your sample balance sheet, there are two accounts listed under assets: checking account and accounts receivable.

Assets are what your business owns.

You own your checking account; any cash in the checking account belongs to your business.

And, accounts receivable is the total of any invoices your customers still owe your business. It’s future cash to be received from customer accounts.

See? Accounts receivable.

When your customers pay their invoices, you receive money from them. You’ll deposit that money in your checking account.

In the example, you have $500 in your accounts receivable.

Let’s say Customer #1 pays $100 for an invoice.

You would receive money of $100 (for this example, let’s say your customer pays in cash).

Your accounts receivable will now be $400 or $500 – $100.

You’ll deposit the money received in the checking account, so your checking account will now be $1100 or $1000 + $100.

We talked about the balance sheet and how everything needs to balance.

In our example of the customer payment, this is how we get balance:

Checking Account (asset) $100 Accounts receivable (asset) $100

There is a debit to checking account of $100, but to keep balance we need a credit of $100.

We credit the accounts receivable account, because it’s the other side of this example.

Remember, debits are any amounts on the left side and credits are any amounts on the right side.

Debits = Credits

$100 = $100

Balance.

Balance Sheet Financials

Liabilities (What Do You Owe in Your Business)?

On your sample balance sheet, there are two accounts listed under liabilities: wages payable and accounts payable.

Liabilities are what your business owes.

Wages payable are paychecks you owe to your employees; the money in this account or category belongs to someone else. In this example, the money belongs to your employees.

And, accounts payable is the total of any bills your business owes to your suppliers. It’s future cash to be paid to vendor accounts.

See? Accounts payable.

When you pay your bills, your pay money to your suppliers. You’ll pay that money from your checking account.

In the example, you have $150 in your accounts payable.

Let’s say you pay Vendor #1 $100 for a bill.

You would pay money of $100 (for this example, let’s say you pay with a check).

Your accounts payable will be $50 or $150 – $100.

You’ll withdraw the money from the checking account when the check clears. Using your checking account balance from the previous section, your checking account will now be $1000 or $1100 – $100.

We talked about the balance sheet and how everything needs to balance.

In our example of the vendor payment, this is how we get balance:

Accounts payable (liability) $100 Checking Account (asset) $100

There is a debit to accounts payable account of $100, but to keep balance we need a credit of $100.

We credit the checking account, because it’s the other side of this example.

Remember, debits are any amounts on the left side and credits are any amounts on the right side.

Debits = Credits

$100 = $100

Balance.

 

Equity (What Is the Value of Your Business)?

On your sample balance sheet, there is one accounts listed under equity: owner’s equity.

Equity is what your business is worth.

Ok, not entirely. But, it is a good estimate of the value of your business.

Remember the accounting equation from earlier:

Assets = Liabilities + Equity

The total amount of what your business owns equals the total amount of what it owes plus what it’s worth. In other words, if you subtract what you owe from what you own, you’ll know the value of your business:

Assets – Liabilities = Equity

Balance.

In the example, equity has an amount of $1000. This would show your business has an estimated value of $1000.

If you were to sell your business or get a loan, the potential buyers or lenders would want to see the balance sheet. It would give them an idea, on a particular day, of how much your business had in assets, liabilities and equity.

Balance Sheet Business

Balance to the Left, Balance to the Right

Now that we understand so much more about the parts of the balance sheet, let’s take a look at this month’s balance sheet.

For this example, we’ll assume the only changes this month were the ones we created in the previous section.

Remember, when you look at your balance sheet, you’ll see

Assets = Liabilities + Equity

In an ideal business, you’ll have more assets than liabilities.

After our transactions from the previous sections, this is your balance sheet as of this month:

Your Business

Balance Sheet

ThisMonth 31, 2018

 

Assets

Checking Account $1000

Accounts Receivable $400

Total Assets $1400

 

Liabilities

Wages Payable $350

Accounts Payable $50

Total Liabilities $400

 

Equity

Owner’s Equity $1000

Total Liab. & Equity $1400

 

What differences do you see? What stayed the same? Why?

The accounts receivable amount and accounts payable amount are different this month than last month.

Remember why?

That’s right. We received $100 from a customer and paid $100 to a supplier.

$100 received and $100 paid. $100 = $100. Balance.

Assets = Liabilities + Equity

$1400 = $400 + $1000

Balance.

All other accounts or categories stayed the same (e.g. wages payable, owner’s equity). Why? Because we didn’t have any transactions that used those accounts.

It’s important for you to know which amounts change, if any, and why. As you can see from the example, your business owns (assets) more than it owes (liabilities).

It’s in an ideal business situation.

To Balance or Not to Balance

Now that you know what the balance sheet is and WHY it’s important to your business and to you as business owner, it’s time for YOU to look at your numbers.

Open your accounting software or spreadsheet and review your balance sheet.

Do your Assets = Liabilities + Equity?

Look at the balances in each account or category from last month. Look at those same accounts or categories this month.

What differences do you see? What stayed the same? Why?

If you have any questions about any of this, drop me a line and ask. I’d be glad to help!

~~~~

Hiya! I’m Paula, sometimes called the “Numbers Counselor”. Here at Small Stepping Stones, I use bookkeeping workflows & trainings to help small business owners and small non-profits (like YOU), one step at a time.